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December 31, 2013

Regular readers of my WTWA series know that I occasionally give the Silver Bullet Award. This recognizes writers who take it upon themselves to debunk dangerously misleading financial analysis. Their often thankless work reminds me of the Lone Ranger, whose adventures often upheld the notion that "...that all things change but truth, and that truth alone, lives on forever."

Over the course of the past year, I included a Silver Bullet segment in my weekly post only a dozen times. As 2013 draws to a close, it seems fitting to revisit these highlights. Each is an important story that you might have missed.

April 21: Mike Konczal reveals key Rogoff and Reinhart errors

It is a long-standing position of mine that financial bloggers have a responsibility to put academic findings into a real-world context for our readers. This is precisely what Mike Konczal did when he broke the story about a celebrated academic study on the relationship between debt to GDP ratios and the rate of growth.

The authors, Rogoff and Reinhart, found that "median growth rates for countries with public debt of 90 percent of GDP are roughly one percent lower than otherwise; average ( mean) growth rates are several percent lower." While financial media had a tendency to portray this result as a consensus within the field, Konczal popularized a competing report that cast doubt on Roff and Reinhart's conclusions. Herndon, Ash, and Pollin - the authors of the new report - found a number of errors within the original study's methodology, concluding for themselves that "relationship between public debt and GDP growth varies significantly by time period and country...[therefore] the evidence we review contradicts Reinhart and Rogoff's claim."

As usual, whoever was writing as "Tyler Durden" did not give a link to the alleged David Rosenberg comment, so we do not know if it is accurate. I get frequent questions from readers about ZH analyses and conclusions. The stories usually combine a smidgen of real data with severe distortion. This makes them difficult to refute, especially when the story appeals to the preconceptions of most readers.

The latest installment takes a single month of real income, distorted by anticipated tax changes, multiplies the result by 12 to "annualize" and make it seem bigger, and then go for the scare. Doug exposes this methodically and carefully. Most readers will not want to consider the full refutation – and that is what "Tyler" counts on.

May 11: Joe Taxpayer busts comparison of the S&P in 2012 to the Nasdaq in 1999

Joe explains: " ...the move from 1250 to near 1600 on the S&P is about 28%. In comparison, the Nasdaq move took it from about 1500 to 4500, a 200% increase. You can easily take any move in the market and with a bit of manipulation, create a chart as you see above. The key in this case is the two different scales, the S&P on the left, Nasdaq on the right. Had the charts been produced using the same scale, they’d show no resemblance to each other."

August 4: Bob Dieli sets the record straight on part-time employment

Bob Dieli won the Silver Bullet award over the summer with a timely reminder on the correlation-causation fallacy. His analysis is now publicly available here, and below are my reactions at the time.

There is a deceptive theme about employment, disparaging the quality of the net jobs created. Some of the writers have obvious political motivations or enjoy reputations as leaders of the tin hat movement. What is alarming is that the theme has gained credibility with some mainstream pundits who spend too much time on the wrong websites. Egregiously bad was the John Mauldin article citing Charles Gave's analysis. Not only is this wrong on the part-time employment issue, it blames everything on QE. I tweet infrequently, but I managed a 140 character response to this one:

To Charles Gave and John Mauldin: Blaming QE for the trend toward part-time employment is like blaming the firemen for the fire.#causation

August 17: Dave Altig tackles the link between employment and low paying jobs

A big thanks to Dave Altig for taking on the alleged link between employment and low paying jobs. As I wrote in August:

[Dave's] creative use of charts and data reveals the truth about employment and low-paying jobs. There is a recurring theme that recent job creation has emphasized the worst jobs. Dave started with a recent WSJ story that captured mainstream thinking. I cannot possibly do justice to this post in a few words. There is a fascinating animated gif that shows wage changes by sector over time, so check out the full article.

Meanwhile, the following chart illustrates one of the themes: The changes are part of a long trend, not a post-recession effect.

September 1: Derek Thompson calls attention to a key error in stats on youth residency

At the time, major financial media sources were abuzz with stories of how 1/3 of young adults were forced to live at home due to a tepid economic recovery. Derek Thompson saw past the gloom of doom and pointed out that college dorm rooms counted as "home" for the purposes of the study. Thompson writes:

It comes down to a very sneaky definition of "home." In the Current Population Survey that provides these figures, "college students in dormitories are counted as living in the parental home." Dormitories! This might strike you as absurd -- and it certainly strikes me as questionable -- but it's Labor Day Weekend, and I'm not going to waste it fighting with the folks at CPS, so there it is. Dorms = your parents' place, according to the government.

This is a huge deal for the Millennials-living-at-home figures, because college enrollment increased significantly during the recession -- 39% of 18- to 24-year-olds were enrolled in college in 2012, compared with from 35% in 2007 -- and college enrollees are much more likely to be living at home (er, in dorms) than students who skip college, drop out, or finish early.

...[the cartoon character] defines money in a very peculiar way so that it doesn’t include anything that doesn’t serve as a store of value. According to his definition money is a store of value, medium of exchange, unit of account, portable, durable, divisible and fungible. He then claims that gold fits this definition. But gold doesn’t fit this definition! First off, you can hardly use gold to buy anything in the real economy. Try going into Wal-Mart with a bar of gold. They’ll tell you to piss off. Better yet, try transporting all your gold around with you where ever you go. Gold doesn’t even fit his own definition. In fact, it fails almost completely in money’s most important function – as a medium of exchange.

Of course, most of our dollars don’t serve as a good store of value. In fact, holding paper currency or even bank deposits is a pretty dreadful way to try to maintain your purchasing power. Does that mean bank deposits and paper currency are not money? Of course not.

November 3: Stephen Suttmeier and Barry Ritholtz on margin debt

Stephen Suttmeier and Barry Ritholtz earned their Silver Bullet Award by addressing the idea that current margin debt levels indicate a market top. This had been on my agenda for some time, so I thought it warranted to a more thorough evaluation:

I have looked carefully at the charts and the variation seems largely coincident, with margin levels sometimes leading and sometimes following...

Merrill's Suttmeier includes the margin debt rate of change as an indicator of whether a rising market is peaking or breaking out. Barry notes, "If the rate of change data somehow corresponds to past shifts in secular markets from bears to bulls, this is potentially a very significant factor."

This analysis is much more sophisticated than what you usually see on this topic. I would love to see more research here, but this provides some needed balance. Here is a summary chart of the basic relationship, but I recommend reading the entire post.

November 16: David Merkel and Tom Brakke on the risks investors face on the quest for yield

Big yields (especially tax-free ones) are so alluring and so dangerous. Most investors can't parse the risks and, frankly, many of those purporting to provide guidance aren't going to bother to educate them.

November 23: Dan Greenhaus adds essential context to a chart by Andrew Wilkinson

This Silver Bullet award was likely the most complicated one of the year. For the sake of clarity, I have embedded the relevant segment from my Weighing the Week Ahead post below:

Indeed, we recently devoted an entire conference speech to pushing back on the idea of an equity bubble. How do we know the story remains? The chart below, overlaying the S&P 500 today against equities in the 20s/30s is now starting to make the rounds. Without getting too personal, "chart overlaying" is lazy and this is no less so. But it does remind us that as much as everyone thinks everyone else is "all bulled up," these views still persist and have shown no indication they are going away any time soon.

This was good work, exposing a typical bogus chart, but there was much more to the story.

It turns out that the original source was Andrew Wilkinson of Miller Tabak. He did the work to normalize the data, generating equal percentage changes. The result is a chart that is a fair comparison of the two periods. Business Insider also covered this story, in a nice post by Steven Perlberg and Andy Kiersz. Here is the comparison chart from Wilkinson's original piece:

The entire story illustrates one of the drawbacks of modern social media. People take something out of context and pass it around. The average person sees the message at face value.

This may be our most complicated "Silver Bullet" story, but I found it fascinating. There was a lot of good work. Sadly, my guess is that most recipients of the bogus chart never saw the refutation.

December 28: Paul Krugman and John Lounsbury on whether a debt "trigger point" exists

Most recently, John Lounsbury spent some time during the holidays to look over some old Paul Krugman papers. I explained to readers the imporance of keeping your politics and your investments separate, and John brought the point home with a couple key charts.

I know that many readers just tune out anything from Krugman, but this is poor practice for investors. One of the key stories of the year has been the austerity debate and the flawed work of Rogoff and Reinhart – still continually cited by those who think you are uninformed. A key question is whether there is a debt "trigger point" that causes a decline in economic growth. Once again, I care as an investor, not as a voter – despite the politically charge that has been applied to the issue. So here are the facts in two charts.

The first shows the relationship with Japan as an outlier.

The second shows the members of the EU with a different marker.

See John's post for the full explanation about why it helps to have your own currency.

Conclusion

As always, you can feel free to contact me with recommendations for future Silver Bullet prize winners at any time. Whenever someone takes interest in defending a thankless but essential cause, we hope you'll find them here. Have a Happy New Year and a profitable 2014.

December 18, 2010

Bespoke Investment Group, a popular and valued source of investment research, has once again conducted a virtual roundtable featuring financial bloggers. This is the second year for this great idea, and I appreciate the opportunity to participate.

They did a wonderful job, starting with an interesting list of questions. I am enjoying reading the answers of my blogging colleagues. It is a nice range of opinion. The question format seemed to get each of us onto themes a bit different from our regular posts.

To get some specific investing ideas, you should read the individual responses as well as the summary article.

At the end of each year, the big financial media outlets typically conduct roundtables to get outlooks from key players in the financial markets. Over the past few years, the individuals that run the best financial blogs and websites have become key players in their own rights, and their opinions are highly regarded by millions of loyal readers. Below is our 2nd annual Bespoke Roundtable with some of the major names in the online financial community, and it's all available for free to anyone with Internet access!

Twelve of the most popular financial blogs/websites agreed to participate in the roundtable. Each participant was asked to respond to the same 34 questions regarding their 2011 outlooks and their take on 2010. Once again we got some incredibly insightful commentary from each participant, and we feel that readers will thoroughly enjoy it.

Below is a list of our roundtable participants. We have created a page for each of them that has all of their responses, and we encourage you to visit their websites as well if you haven't already done so.

The matrix below summarizes some of the specific forecasts. The article itself is the place to start, since it provides a good sense of the range of opinions. If you want more, you can click through on the list above. You can see every response to every question.

It is the season for taking a look ahead. The 2011 Roundtable offers some healthy debate and some specific ideas, all in a user-friendly format.

January 31, 2008

Most individual investors make a major mistake: Looking for a "hot hand." They spend a lot of time and money chasing last year's (or last month's!) performance. Quite frankly, this is also the attitude of many top Fund of Fund managers who earn big salaries. Find the hot hand!

Why? The biggest reason is that it is easy to do. Anyone can look at performance versus benchmarks and act decisively on the basis of a little information. Even long-term track records can be unpersuasive to those who decide that the manager has "lost it." The recent track record seems like unassailable, objective evidence. In fact, it is one of the fastest ways to lose money.

Why are Warren Buffett's investors willing to sit through a weak stretch of performance? Because they understand his approach and methods. He makes sense. Combine this with the long-term record, and it is quite reassuring.

Evaluating Trading Systems: A Source of Confidence?

Evaluating a trading system can, in theory, provide as much confidence as reading one of Warren Buffett's annual reports. Since very few people have this skill, it is even more valuable. Most trading systems offer eye-popping results that can never be attained in practice, usually because the developer created a perfect fit to all of the past data. Most system evaluators become accustomed to seeing these claims and expecting much less.

The average investor may not have all of the quantitative and methodological skills to evaluate a trading system, but it is right to be wary of anything that seems too good to be true. Every method has periods of losses and imperfect signals.

Confidence in one's approach is the key to taking action even when times are challenging. Those who lack a system flit from idea to idea, always trying to catch the last wave.

TCA-ETF Update

As we have been doing each Thursday for several months, we are attaching the weekly update of our TCA-ETF model. This was designed as a means for readers to look over our shoulder as we designed and implemented a new method. We also thought that other ETF investors might find our rankings to be interesting.

Somewhat to our surprise, we got a number of inquiries about investing in such a program. Since this is a daily trading system for a limited partnership we are limited to 99 accredited investors. But it got us wondering. Could we adapt the program so that the average investor could enjoy the same technological advantage. After some thought about trading frequency and number of positions, we did a five-year test of the model. We were delighted by the results. It turns out that weekly trading of ETF's is almost as good as daily portfolio adjustments.

This program is immediately available to any interested investor for whom it is suitable. The model is just starting a new cycle, and the Gong has sounded. We believe it to be a good time to begin or add to equity positions. One advantage of the TCA method is that it goes completely to cash in extended bad times. The investor does not need to worry about trying to do market timing.

We will provide a report on the methods and testing to anyone who is interested in taking a look.

This week's ratings are a little misleading, since we use the Wednesday closing data. Today was an excellent day, and we now have a total of six positions out of 44 ETF's in the universe. Below is the table as of yesterday's close.

January 22, 2008

There is an old rule -- and a good one -- for traders: Do not let a trade turn into an investment.

For individual investors we submit the alternative: Do not let an investment turn into a trade!

Individual investors tend to look at big declines and bail out of their positions at market bottoms. They are trying to time the market. This is a mistake related to time frames, a topic we have carefully covered.

The individual investor is likely to look at a newspaper and think that it provides fresh information, even though the market may have already factored this in. Individuals also get worried when markets decline, something that is a natural and recurring event, and choose to sell at the worst possible moment.

Acting effectively at these times requires an extensive knowledge of overall factors, market valuation, and overall potential. Few investors are willing to do the homework required to make these decisions.

It also requires experience, and an understanding of behavioral psychology. These are times when one's investment advisor earns his fee.

The Big Mistake

Investors get afraid, and do so at the wrong times. Here are two interesting perspectives.

A trader on CNBC was commenting on his morning trades today. That trader was buying the big opening decline (as were we) and wondered who was selling? "What were they thinking?", he mused.

My RealMoney colleague Scott Rothbert, the finance professor and fund manager at Lakeview Asset Management, has a wonderful educational series for investors at TheStreet.com. It is both free and valuable. An individual investor should set aside time to read the entire series. Scott wrote at length this morning. Here was the "money line" for the individual investor:

If you are an investor then invest but don't switch gears into trading
mode just because of current market emotion. Sticking to your model is
another one of my basic tenets.

This is wise counsel from someone who has been there and knows.

Is it Time to Add to Positions?

Individual investors who have too much of their portfolio in cash, bonds, or real estate, should be asking when to add to equity investments. This is the one time to think about what traders are doing.

Adam Warner is trading, not buying, and doing it against an options position. He is not trying to time an entry point, and his viewpoint deserves respect.

Pradeep Bonde discusses the days after 9/11 and the poor advice from talking heads on CNBC. We remember this and agree with Adam. The market will find a valuation level that reflects expectations. The time after 9/11 was not one where investment managers would do "patriotic buying." Investment managers were trying to figure out what stocks were worth. They were (sadly, but obviously) worth less than they were before the attacks. The question now is how much of the current concern is "in the market." We agree with Pradeep that one cannot know by watching interviews on CNBC.

Brett Steenbarger looks at other panic situations and analyzes subsequent returns. Dr. Brett is the "go-to guy" on trading psychology. His conclusion is especially meaningful for the individual investor:

The moral of the story is that, in the short run, panicky markets can
decline further. Investors with longer time horizons, however, have
generally done well by putting money to work when panic fills the air.

Our Take

Our conversations with investors show that many are too heavy in cash and real estate. The market has offered an opportunity to change the asset allocation at favorable prices. We are finding many attractive stocks.

The Fed is on the case. The President and Congress seem to be working toward an agreement. Since many pundits do not understand how government works, they underestimate the potential. For many investors it is time to do some buying.

Another wise commentator on CNBC, Vince Farrell, suggested "dollar cost averaging." What he means is that there is an opportunity to take a partial position. If stocks move lower, buy more. If stocks move higher, at least the investor can participate.

This is good advice for the nervous investor, something that we have successfully suggested in the past in our discussions of "when to pull the trigger." It is much better than selling at the bottom.

January 01, 2008

A consistent theme at "A Dash" has been the application of knowledge that is well known in social science, but not understood by most market participants. This is something you will not read anywhere else.

In political debate, one of these themes is definition of the agenda. Those who define the terms of the debate will win.

The challenge for investors is to understand and to apply this concept. Most market pundits define the question in a way where they have an obvious answer.

But what if they are asking the wrong question?

A Typical Example

The current market comment from John Hussman (excerpts on Seeking Alpha) argues that central banks are doing "liquidity absorbing" transactions so the "liquidity injections" are misleading to investors. We cannot find a good quotation to summarize this, so read the article to check yourself.

Regular readers of "A Dash" will readily see the problem. So will anyone who is following blogs by economists. The Hussman evaluation does not accurately describe the policy goals of central banks.

Central banks are doing two quite different things. They have reduced interest rates and added liquidity. They have also adopted innovative methods to get liquidity where it is needed. This includes the ECB injections, the Fed's TAF plan, and the swap agreements between the Fed and European Central Banks.

Conclusion

We attempt to avoid ascribing motives to market pundits, but we are mystified by the Hussman commentary. He is an informed observer, albeit one who has been on the wrong side of the market in recent years. It would be more useful if he were to comment on how the various liquidity moves were working in terms of the stated goals of the central banks.

Instead he is setting up a straw man and knocking it down. This is a classic debater's tactic. Astute investors should beware of pundits who ask the wrong questions. Discovering the real issues, and the right questions to ask, is one of the most important challenges to an investor seeking to understand the global economy.

New Year's Resolution: Think for yourself in determining the right questions. Read critically. The first step to good investing is defining the issues and the agenda.